What’s Dutch For Escargot?

N.V. Philips sees itself in a new light. New patterns of competition are forcing Europe’s first true multinational to reorganize as a global (as opposed to multi-local) competitor. The strategy is correct, but can CEO Cornelis J. van der Klugt make it happen quick enough?

Tall and handsomely weathered, Cornelis J. van der Klugt, 63, has the steely-eyed bearing of the kind of 17th century Dutch admiral one imagines commanding the epic sea battles painted by Van de Welde. The impression is enhanced by the orange and blue Order of Oranje-Nassau decoration, bestowed by Queen Beatrix of the Netherlands, worn on his lapel. A company man for 37 years of his working life, he took the helm of NV Philips Gloeilampenfabrieken in 1986 from Wisse Dekker-at a time of much soul searching in Eindhoven. The firm has been headquartered there since 1891, when Frederik Philips and his son, Gerard, first produced incandescent lamps in a small factory.

As it approaches its centenary, the $27 billion group is showing signs of wear. It is the world’s second largest maker of consumer electronics (Matsushita is first), the largest lighting equipment producer, and the leading European manufacturer of semiconductors and components. It also has significant defense, telecommunications and domestic appliance operations. Although it achieves steady volume growth of around 7 percent annually, profits are low and getting slimmer. In 1984, net after tax margins on a GAAP basis were 2 percent. In 1987, it fell to 1.2 percent and is expected to remain low for 1988.

Currency shifts don’t help. Some two-fifths of its sales are denominated in dollars, and the sharp fall in the dollar more than offset its volume gains. It is also plagued with high manning levels, a heritage of its paternal role in European public life. Like its Japanese rivals, Philips traditionally operated for employees first, shareholders second.

Philips is the only remaining competitor able to stand up to the Japanese and Koreans in consumer electronics. Before van der KIugt’s succession (he took charge of that division in 1978), the board questioned whether the company should continue to do battle in a field where it appeared to be entangled in its own rigging. Its problems were evident: an inefficiently fragmented production organized along national lines (it operates in 60 countries), and a high cost base centered in Western Europe. Were it not for the consolidation of its Polygram record label, Philips’ consumer electronics unit would not show a profit at all.

In fact, if Philips were on the same footing as a US. or UK corporation, it would be a raider’s dream. It’s recent share price of $15 is less than a third of its $55 net asset value. The planned 1992 harmonization notwithstanding Philips’ complex legal and ownership structure immunizes it to some degree to a U.S. style buy’em and bust’em attack.

The group’s strengths are not inconsiderable. It enjoys a deserved reputation for high quality products and a venerable brand image (Philco, Magnavox, Sylvania), a solid customer base and an impressive record of technological innovation. Philips has long been aware of the need to trim fixed costs and boost profitability. The question remains: Can management do so quickly enough?

From Wall Street to London’s “City” exasperated money men throw up their hands. “I wish I could recommend Philips, but 1 can’t,” says Henry B.W de Vismes, managing director, Kleinwort Benson International Investment and president of its Transatlantic Growth Fund and Income Fund. “It’s performance continues to disappoint. Their [earnings] projections are often wrong. It’s a shame, because somebody could really do something with that company.”

That somebody might just be Cor van der Klugt. As president and chief executive, he has axed overhead and streamlined production along global as opposed to national lines. He installed Gerrit Jeelof vice chairman of Philips’ management board as chief executive of North American Philips Corp., which became a wholly-owned subsidiary in 1987 when Philips bought the 42 percent interest that had been publicly owned. The move signaled a shift away from the fragmented confederation of national organizations towards an emphasis on product groups and global sourcing. “He has brought a new atmosphere of urgency and concern to the bloated bureacracy of Eindhoven,” allows Kleinwort Grieveson analyst Chris Honnor.

Skeptics like Angela Dean, electronics analyst with London’s Robert Fleming Securities Ltd. would like to see “clearer action,” and more tangible signs of a turnaround in electronics. “Looking at the track record, perhaps Philips should be more in a hurry to raise cash.” The group continues to cover less than half of its financing requirements internally. It has also been criticized for listless joint ventures with AT&T in information technology, and with the German electronics giant Siemens, concerning the Mega project. After negotiations with Britain’s GEC over the merger with Picker International fell through, Philips was gaining unfairly, a reputation for being unable to make deals. It has since concluded a joint venture with Whirlpool where the latter has taken a majority stake in the former’s household appliance operation.

In auditing its strengths and weaknesses, van der Klugt correctly points out that Philips has never lost sight of the need to maintain core technologies-something which American CEOs preach, but rarely practice. This is why the group doggedly holds onto its position in consumer electronics. Philips’ experience with compact discs-which it introduced-is a good example of converging technologies and the link between consumer and professional systems. Say what you will, Philips never shorts the long-term in its R&D. Having spent half a billion dollars in restructuring itself, it is in a position to give Matsushita, Sony, Goldstar, et al, a run for their money.

Van der Klugt is nothing like the dour Dutch bureaucrat one might suppose such an imposing institution might produce for its el supremo. Confident, but realistic, he displays a commanding knowledge of facts and trends with literate wit and a taste for irony as the following exchange attests: Of our ancestors weren’t in haste to cut that deal for Manhattan with the Indians, you would be interviewing me in Dutch instead of English,” he quips.) He plays tennis three times a week at 7:00 A.M. and likes to ride his daughter’s 10 year-old bay horse on Saturday mornings for relaxation. The honors of a Philips chief may be manifold, but what really pleases him is the occasional invitation by his Hobie Cat champion son to go out sailing. “It’s not easy getting invited on that boat.”

The next 12 months will tell if Philips is captained by a latter day [Admiral] de Ruyter or de loser.

Philips’ ability to invent new products is well established, but it is less adept at marketing them. Are you changing this?

I would say the opposite is true. Philips is a top-notch marketer that now and again produces interesting technological concepts. One of our most famous products, the Norelco shaver, has nothing to do with research and development. [It has to do with ] championship marketing.

Take light bulbs. They’re high-tech now, but for many years they’ve been a low-tech business in which we have held 41 percent of the world market. Our market leadership has nothing to do with Nobel prize-winning ventures. On the other hand, we’ve had one or two unfortunate marketing results from things we’ve introduced to the U.S., such as the video disc. This was due to underestimated technical problems and our “banana-peel stepping.” Yet, we’re largest in lighting, in TV picture tubes, and among the top three in television sets. It’s true our marketing effort in the U.S. isn’t what it should be, but our world leadership in these other areas is due to nitty-gritty marketing, not to technological advances.

Philips introduced the audio cassette; today one can’t find a Philips blank cassette in a U.S. shop. Philips developed the video cassette recorder; today the market is dominated by the Japanese and, to a lesser extent, the Koreans.

Japan started after the war with no export performance and a very poor quality image. The U.S., and rightly so, gave them a hand. Japan appealed to American experts like [W. Edwards] Deming and [Joseph] Juran to teach them statistical quality control. The Japanese achieved success by supplying products that at first were marketed by Americans. It was only after about 10 years of this that they started marketing on their own. Getting 38,000 outlets via RCA, for example, is something money can’t buy, yet the Japanese got it for free.

If marketing isn’t Philips’ weakness, surely its cost structure is?

Our situation is not exceptional. We have no trouble in the lighting business, and we do very well in small domestic appliances. We do quite a bit in professional electronics, too. We may be weak here and there, but we intend to grow. We intend to double our information technology activities over the next five years.

Making money in consumer electronics in the U.S. is difficult because the Japanese and Koreans can sell a product here for half the price it would cost to sell it in their home country. Anyone working from Europe has an unfavorable cost structure to start. A European engineer works 1,600 hours a year, a Japanese engineer at least 2,400, and a Korean 2,800, for half the money a European receives.

How are you trimming costs to deal with this?

By getting leaner and meaner. We’re cutting out functions that don’t contribute to the bottom line and removing levels of management.

How many?

From the man on the shop floor to the man at the top, there are about 10 to 14 levels; we’ve taken out one or two of the lowest-which is a minimal expense-but we’ve also streamlined the top by pensioning off 40 percent of our board members and flattening the organization.

In the end, about 30 percent of the layers will be dropped. In addition, we’re moving to larger European scale manufacturing units as opposed to national units, something that will be possible in a Europe without borders [1992]. This gives us a chance to design out expensive labor and robotize the process.

We’ve found a better approach to making things, one that Japan developed from scratch 30 years ago. It’s a process I call “comakership.” Let me give you an example: We want a mold made for a cabinet. Under the traditional system, we first design the mold, then approve the drawing, then recheck the approval; it’s then handed over to the purchasing department which requests prices from half a dozen different suppliers -each of whom factors in every conceivable cost into his estimate to follow that very precise drawing. This takes three months-even if you’re quick.

The Japanese do this differently. They’ll bring in one supplier who’s an expert in molds and say, “I have a vague notion of how this cabinet should look, but we’re certain that 80 percent of the mold is not subject to narrow tolerances until the last phase, so why don’t you start working on it with us as we know more?”

Here’s parallel action. By the time one knows what he wants the mold to look like, his supplier is already making it. This works because the guy isn’t asking prices of six people, intending to leave five in the lurch. By securing a “co-maker” partnership, the process can speed up-unless of course the partner fouls up. But he’s not likely to do so; he knows he won’t be left in the lurch. His business may ultimately fail, but not for that reason.

Where are you implementing this “co-making” process?

In Europe, one can see it in our compact disc facility in Hanover (W. Germany) which produced the first gramophone records in the 1890s. It’s an old factory that has been transformed. Unlike a shellac record, which is simple to make, compact discs are like transistors or integrated circuits that require clean surroundings and repeated galvanizing layers. In getting the raw materials, our Hanover people talked to two or three chemical companies and chose to work with one on the process.

They didn’t bid on the job?

There was nothing to bid on yet. They said, “Here’s what we need. Let’s work together and see if we can come up with a material that works. If you can, we’ll work with you.” That was the first step.

Second, Hanover had to solve the submerging process which CDs undergo. This was done not on the basis of preparing a drawing and getting bids, it was done by going around to various firms within a 50-mile radius of Hanover and asking, “Can you help us solve this heat problem?” This has facilitated the manufacturing process a lot. There’s a greater closeness. People from different companies call each other up to talk about problems. It’s like Silicon Valley.

We’ve also done this around the mother factory in Belgium which makes compact disc players, and in our Monzi, Italy flow-line installation which makes, as far as we know, the cheapest 14-inch television set outside of Korea. It exists too, to some extent, in our Knoxville, Tennessee consumer electronics installation.

If marketing isn’t your weakness and you reckon you’ve solved the manufacturing problem, why are profits so slim?

Hah! Have you gone to a Jesuit College?

First we had to gear up to become a real global company as well as a real common market company. Of the nine picture tube factories, for example, six have had to be eliminated and three were built up. That alone cost us a large amount. In 1987, restructuring cost us $250 million. Yes, we could squeeze a few more years out of some of these plants, but we would no longer be in the big leagues. We don’t like to do it, but such measures are necessary to get in shape for world competition and ultimately to penetrate Japan.

Second, apart from these costs, we’re going to eliminate between 15,000 and 20,000 indirect jobs-mostly staff jobs. The redundancies will lower overall costs by about $500 million. We won’t show much profit during this sacrifice. It’s real expensive to get rid of people. It costs $75,000 to let a worker go in Spain; and we had 8,000 of them in Spain! Now what am I going to do with the 4,000 people in Barcelona? It’ll be transformed into a bigger unit producing a million or more units for the entire common market, not just Spain. If everything goes well, we’ll see the turnaround this year.

If we see each other a year from now and you reproach me for not predicting accurately, it’ll likely be due to world dumping and the bloodletting of margins in European markets. But I don’t think this will happen. We’re sticking to our guns.

How will you fight the two most important battles now being waged for the future of consumer electronics dominance, namely, the standardization of digital audio tape (DAT) and high definition television (HDTV)?

After the compact disc fight, we sat down with the Japanese to determine which of the two then competing standards would be used for DAT. It’s interesting, but they prefer the gaijin [foreigner] to decide this. If the foreigner does it, Matsushita doesn’t have to kill Sony and Sony won’t have to commit seppuku [suicide] because Sanyo didn’t go along. (This is also true of HDTV.)

It was interesting because they regarded Philips as their master in terms of knowledge-not in terms of performance. (We think we’ll get there one day.) As you know, we have a 35 percent interest in Matsushita Electric Company and have a 10 year technical assistance contract which has been renewed for another 10 years. Maybe you’re right in that this knowledge should be realized in marketing our own products-not with somebody else’s. But in the meantime, we’re getting something.

With these people around the table it was agreed that the RDAT [Rotary Digital Audio Tape] system would be the official DAT standard. At this point we said, “Wait! Make certain you get the software industry to agree to this standard.” People buy the music, not the box-all we’re selling here is the box.” Mr. Ishiro Shinji of JVC said, and I’ll never forget this, “Let the Americans solve their own problems.” I told Shinji and [Akio] Morita [Sony] that they had better talk to the software industry, which is, in essence, the U.S. Next thing I knew , a flurry of Japanese newspapers were reporting that Philips was pleading with the Japanese not to start DAT because we were not ready.

None of this was true. We had learned from our experience with the audio cassette -which we freely made available to the world-and with the compact disc from which we collect royalties. If a top quality tape was introduced with CBS and EMI and earned no revenue, it would never have gotten off the ground.

At the meeting in Canada, the American record industry came away furious because the Japanese simply refused to listen. I can excuse the Japanese, to a degree, because they don’t produce classical or popular software; they have no experience. They assume that if they start selling DAT, things will start coming together by themselves, but they won’t. It’s less than a year since Sony acquired CBS Records and there’s still no breakthrough, which proves that you may be the owner and still not be able to call the shots. It’s a nasty problem because no one wishes to mutilate a technology merely to protect their interests.

Why not do what the Japanese do and impose your own standard on the market and force everyone to catch up?

We can’t. You need a large market share to do it, and no one does.

Nobody has a dominant market share for DAT because there’s no established market yet.

We don’t have a standard. We have merely proposed to have certain devices be applied within the DAT unit so that it becomes a once-only copying device. This cannot be achieved alone. You need the whole industry behind you. The CD experience is the example of how it’s best done.

You must be somewhat lucky to pick the right moment when a concept is right to be standardized. I had my first historic meeting with Akio Morita just down the corridor from where we are speaking [North American Philips New York headquarters] nearly four years ago. He would make a point of stopping by to see our people, and I would casually drop by for periodic chats. He and I agreed that the CD was a worthwhile concept. He took the responsibility of gaining the commitment ofJapanese industry, and I had the duty of convincing the rest of the world. There is no equal to the CD’s success. It held more than 5 percent of the market in less than five years.

What’s your strategy for HDTV?

In Europe, we have taken the first step toward a satellite broadcast system called D2 MAC. On October 27, 1988, the first satellite offering this system was launched. A patch [unit] is available-to those who buy it-to use within existing TV sets to receive the signal. We will soon be making integrated sets with the new system, which will be a little more expensive than those now sold.

As you know, there’s a production standard and a transmission standard and that’s what we’re talking about. Japan Broadcasting Corp. [NHK] worked on American broadcasters to adapt their production standard based on the MUSE system. It’s a good system, but when NHK tried to force MUSE on the Americans for a transmission standard, it ran into problems. For one, MUSE can’t be received by existing sets and it isn’t suitable in countries like mine for example, that have a high degree of cable networking. This means people would have to throw out their old sets and buy new ones. No one in Europe is going to do that, and God himself couldn’t sell Europeans on the idea.

We don’t think that’s good business, so we’re adopting the same approach used in the introduction of color TV. Anyone with a black and white set can continue to receive a signal. Remember the multiple record standards: 78, 45, and 33 rpm? They coexisted. It’s a proven. I think there’s a better than average chance that the FCC will accept the Philips concept. NHK, on the other hand, continues to force and bully its own system. Not long ago, after NHK got cold water over its head, Mr. Kenji Shima offered its system to us at cost. Can you believe it? I told him, “What you’re offering is an impossible system. You want to make me a slave as long as I pay my own price.” In HDTV, as in DAT, the Japanese don’t want to talk to anybody. Of course in Japan, everybody is scared of NHK. But, on the other hand, Japanese makers fear being painted into a comer. Ultimately, the Japanese will come around quickly and adapt with a compatible system. Our system is equally as good as MUSE except that it’ll take four or five years to get there.

Once you’ve sorted out standardization, will Philips be able to ship products good enough and fast enough to capture top market share?

We’ll have extended definition TV by the beginning of 1989. By the end of the year, Europe will have 42 new channels. We have indoor/outdoor units, the small DBS dishes, the patch units, and the integrated sets.

The answer is yes-in Europe. The U.S. has not made a decision yet, but our Signetics semiconductor unit [in Sunnyvale, CA] and our consumer electronics unit in Knoxville are on the ball and won’t stand back for anybody.

Why do you believe, as you have said, that “the Japanese are past their apex?”

That’s more blunt than how I phrased it, but, yes, there are questions one can ask: What will happen to Japan as its population continues to age? What will happen to social security costs? Education? Can it continue directing only the top people to universities? What will they do with those who aren’t “geniuses?” How long can you make people live the rigorous existence? They don’t enjoy big houses or big refrigerators, weekend houses, soft beds and sailing boats. I’m not knocking it. I admire it. But this cannot continue for a long time. How long is a long time? Certainly no more than another 20 to 25 years.

The real question is, “Will Japan increase its competitive advantage with the West?” The answer is no. They’ve gone as far as they can conceivably go. The big U.S. semiconductor companies formed [a research consortium] Sematech which signals the end of American submission.

Hah, finally! We’ve been telling Americans that they’ve been giving away their knowledge for nothing. Each dollar you pay them is 10 cents for the bullet that’s going to kill you. Even our North American people were chiding me saying, “You can’t say this to Americans.” We said, “It’s o.k., they’re not listening to us anyway.” The U.S. will not let things get too far away from them. If mainframes, aircraft, and ultimately space technology moves to Japan, what have you got left?

The president of one of the leading U.S. aircraft manufacturers (I don’t wish to say who) developing the most advanced military aircraft, told me that the aircraft has 3,000 microprocessors and there’s only one U.S. maker of these left. In five years, will his successor be forced to go to Japan to find them? Will SDI be “Made in Japan?” I exaggerate, but this is where these things lead. That’s why I think Japan has gone as far as the world will let it go.

Will the international competitive position of the U.S. improve or worsen?

It will get better.

You’ve got no more than three years to turn this company around. Will you be able to do everything before you step down?

Well, Jesus Christ did it in three years!

Yes, but he had 12 helpers.

That’s true; and I only have 10. Seriously, I think we’ve got the message out. The top layers of management know. Now we’re reaching out to the middle levels. As I mentioned, we sacrificed 1987 and 1988 to restructure. We’ll do better in total profits in 1989. This will smother some of the criticism which, I admit, is justified. We’ll make our profit target [3 percent after tax] by 1991, too.